Saturday, July 7, 2007

I was talking to some one in the business the other day and they asked me if I owned any Energy stocks. My first instinct was to shudder in horror. Energy stocks value? At the peak of the cycle? After 5 years of unbelievable outperformance and with commodity prices higher than ever? And then I started to think about it and realized that value has a very slippery definition.

Value is one of the words like “beautiful.” Everyone has his or her own perception of what beautiful is. So just like the old cliché “beauty is in the eye of the beholder,” so to the definition of what a “value” stock is, is in the eye of the beholder. There have been times where I have looked at quarterly reports from mutual fund companies that are dedicated to value investing and just shook my head in wonder. How could that stock be a value stock? And then I would remember what a great long-term record that manager has.

Here is a theoretical argument about what value means in terms of Energy stocks. Let’s say that you are a believer in the theory of peak oil. I don’t want to get too deep on what that means so here is a good web site if you want to really get into it:

It basically states that the world is at or near its peak in terms of oil production, and we will soon see declines in that production. Since demand is rising due to global industrialization, this mismatch will cause a major step up in prices, etc.

Now if this comes true, and I am not passing judgment on this argument right now, doesn’t that mean that all those oil reserves on the balance sheets of the integrated oil companies and the exploration and production companies are vastly undervalued by the market? That would make them “value" stocks then I guess. If the market is valuing these stocks based on long term prices of oil at $30-$40 but the long term price will be twice or triple that, then owning those stocks is certainly a value play.

Now the stereotype of a value stock is one that has been beaten up in price, the fundamental outlook has deteriorated and most investors generally scorn the stock, but what if that is too narrow a way to look at the issue.

I am not making a call on loading up on Energy stocks mind you. I just wanted demonstrate theoretically how a market darling group like Energy could be viewed as "value."

6 comments:

An interesting and truthful point you have made here...Value is definitely a subjective word and I'm relieved to know that I'm not going crazy when I get weird looks from people when I say that I "value" a certain stock....Thanks!

You have reminded me of a conversation that I had with an elderly gentleman almost a year ago. He spoke to energy as a good and timeless investment and he contrasted it to gold.

He pointed out the degree to which energy was integral to the economy, and that gold just sits in a vault somewhere.

Energy is what drives the economy according to this gentleman, it is for transportation and heating, it plays a role in all other products made or sold, it is where our plastic industry comes from and, well, he did go on.

He did concede that last summer energy may have been on the high side, but fundamentally regardless of what happens to the economy energy will be a driving force within it, and that was what he was saying was important in an investment.

Price of a strategically vital metal, palladium, rallied from $145 in 2003 to almost $400 recently, this happened with global production of 7M ounces per year, and on top of that the Russians dumping 1.8M ounces per year from their strategic stockpile. With such extreme over supply palladium should be extremely bearish, but it had been very bullish for the past four years? WHY?

Many experts believe the Russian stockpile is running low today! They can NOT continue this massive dumping. Lots of investment entities saw this and positioned themselves and silently loading up physical palladium. Once the huge Russian dumping is cut off, expect palladium price immediately shot to sky high!

This speaks extremely bullish for a little known stock called SWC, the only US based palladium producer, and richest palladium mine in the world.

An explosive 20 folds gain within 4 years or shorter can be expected. That's 2000% gain!

Thanks for the comments...Barra is one of those who does a terrible job of separating growth and value. As I remember it, they sort the entire S & P 500 by price to book and then put the top 250 into growth and the bottom into Value.